Enhancing Loan Quality through Transparency: Evidence from ......Motivation Loan securitization is...

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Enhancing Loan Quality through Transparency: Evidence from the European Central Bank Loan Level Reporting Initiative Bank of France October 23, 2015 Aytekin Ertan, LBS Maria Loumioti, USC Regina Wittenberg-Moerman, USC

Transcript of Enhancing Loan Quality through Transparency: Evidence from ......Motivation Loan securitization is...

Page 1: Enhancing Loan Quality through Transparency: Evidence from ......Motivation Loan securitization is an important credit market innovation that allows banks to diversify credit risk

Enhancing Loan Quality through Transparency:

Evidence from the European Central Bank Loan

Level Reporting Initiative

Bank of France October 23, 2015 Aytekin Ertan, LBS

Maria Loumioti, USC

Regina Wittenberg-Moerman, USC

Page 2: Enhancing Loan Quality through Transparency: Evidence from ......Motivation Loan securitization is an important credit market innovation that allows banks to diversify credit risk

Research question

Can transparency alleviate agency costs in

loan securitization and improve loan quality?

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Motivation

Loan securitization is an important credit market innovation that

allows banks to diversify credit risk and firms to gain easier

access to credit (e.g., Nadauld and Weisbach 2011, Benmelech,

Dlugosz and Ivashina 2012, Bord and Santos 2014, Loumioti and Vasvari

2015)

Securitization was blamed for playing a detrimental role in the

financial crisis by giving rise to severe agency problems in loan

underwriting, screening and monitoring (i.e., insufficient

screening and information collection [Keys et al. 2010, Garmaise

2015, Demyanyk and Hermert 2015], lower monitoring incentives [Kara

et al. 2011, Wang and Xia 2015]).

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Motivation

In the aftermath of the crisis, market participants called for greater

transparency that would facilitate better assessment and pricing

of banks’ credit risk-taking.

However, whether transparency can effectively influence banks’

behavior and credit practices and alleviate risk-taking in

securitized transactions has yet to be empirically explored.

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Setting

Starting from 2013, banks that pledge their ABS as collateral for

ECB repo borrowing are required to quarterly report to ECB the

structure and performance of the loans in these ABS deals.

Reporting is standardized and follows a predetermined format that

is set by ECB.

If a bank fails to report, it is barred from ECB repo borrowing.

Reporting and monitoring of the bank data is administered by an

independent entity, the European DataWarehouse (ED).

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Hypothesis

Greater transparency will incentivize banks to issue and securitize

better quality loans.

Information collection

The comprehensive and recurring information collection required by

the new standards will result in a greater information set being

available to lenders when making credit decisions.

In turn, this will enhance banks’ screening efforts and underwriting

standards.

Market discipline

Detailed loan-level disclosure should assist investors to more

accurately assess the riskiness of securitized loan portfolios.

These disclosures are standardized and will therefore allow investors

to compare underwriting standards and securitized loan performance

across banks.

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Confounding factors

Over the past few years the ECB – the primary investor in SME loan-

backed ABSs – has lowered credit standards in an effort to support

highly-leveraged banks (ECB Euro Money Survey [2012])

- Thus banks may not feel pressed to improve their securitized loan

quality.

The inherent complexity in securitized portfolio structures may deter

investors from effectively processing loan-level information.

- Investors expressed concerns with respect to integrating and

utilizing loan-level data to achieve efficient and consistent analysis

of ABS deals.

Greater information collection on loan and borrower performance might

not translate to better credit decisions by loan officers.

- To enhance credit decision quality, banks may also need to invest

in training personnel and improving their monitoring and control

systems.

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Sample

974,717 loans to 606,396 SMEs issued by 37 banks from 2009 to

2014.

Loans are securitized in 73 ABS deals of banks in Portugal, Spain,

France, Belgium, Italy, Germany and The Netherlands.

We focus on small- and medium-sized enterprise (SME) loan

securitizations.

Sample selection

Observations

Securitized loans originated in 2009Q1-2014Q2 and reported in 2013Q1-

2014Q2 from 37 banks 3,845,770

Obscure/Codified data provider bank name 271,203

Missing interest rate, loan amount and/or maturity 448,527

Recording date is after loan maturity date or before loan start date 164,823

Total 2,961,217

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Transparency and securitized loan quality

(I) (II) (III) (IV)

Default=1 Delinquent amount Number of days in

delinquency Loss given default

Transparency loan -0.020*** -0.195* -0.042** -0.024**

(-2.79) (-1.70) (-1.98) (-2.11)

Interest rate 0.011*** 0.305*** 0.041*** 0.004**

(9.41) (7.86) (7.34) (2.29)

Secured 0.017*** 0.193 0.051** -0.053*

(4.30) (1.05) (2.39) (-1.66)

Years to maturity -0.002 -1.405*** -0.007 -0.038***

(-0.68) (-5.41) (-0.56) (-4.83)

Securitized loan amount 0.001 0.816*** 0.063** 0.013

(1.14) (2.60) (2.10) (0.68)

Lending relationship -0.009*** -0.154*** -0.016*** -0.012*

(-3.20) (-2.61) (-2.58) (-1.79)

Loan purpose FE YES YES YES YES

Loan type FE YES YES YES YES

Borrower industry FE YES YES YES YES

Borrower type FE YES YES YES YES

Reporting quarter FE YES YES YES YES

ABS deal FE YES YES YES YES

N 2,729,323 2,961,217 2,961,217 2,961,217

Pseudo -R2 14.07%

Adj.-R2 4.43% 7.37% 44.21%

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Transparency and securitized loan quality

Are the results driven by time –varying supply of

better loans?

Are the results driven by ECB monitoring of

banks?

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(I) (II) (III) (IV)

Default=1 Delinquent amount Number of days

in delinquency Loss given default

Transparency loan -0.009*** -0.104* -0.029*** -0.003

(-3.28) (-1.92) (-3.14) (-0.70)

Interest rate 0.004*** 0.086*** 0.023*** 0.003

(6.04) (2.59) (3.26) (0.40)

Secured 0.003*** 0.029 0.003 -0.059

(2.49) (0.55) (0.46) (-1.16)

Years to maturity -0.005*** -0.313*** -0.020*** -0.046***

(-4.22) (-3.16) (-3.11) (-5.54)

Securitized loan amount 0.013 -0.835 0.048 0.090***

(0.43) (-1.24) (3.33) (3.59)

Lending relationship -0.004*** -0.066** -0.006 -0.019

(-2.61) (-2.04) (-0.74) (-1.18)

Loan purpose FE YES YES YES YES

Loan type FE YES YES YES YES

Borrower industry FE YES YES YES YES

Borrower type FE YES YES YES YES

Reporting quarter FE YES YES YES YES

ABS deal FE YES YES YES YES

N 161,216 167,985 167,985 167,985

Pseudo -R2 44.30%

Adj.-R2 7.55% 5.09% 24.67%

Transparency and securitized loan quality:

Loans originated in 2013Q1-Q2

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(I) (II) (III) (IV)

Default=1 Delinquent amount Number of days in

delinquency

Loss given

default

Transparency loan -0.021*** -0.195** -0.043* -0.026**

(-2.68) (-1.96) (-1.87) (-2.00)

Interest rate 0.011*** 0.305*** 0.049*** 0.037**

(6.15) (7.86) (9.50) (2.17)

Secured 0.018*** 0.193 0.071** -0.041

(3.99) (1.05) (2.29) (-0.86)

Years to maturity -0.001 -1.405*** -0.016 -0.045***

(-0.43) (-5.41) (-1.09) (-4.09)

Securitized loan amount 0.012 0.816*** 0.093** 0.004

(1.00) (2.60) (2.45) (0.22)

Lending relationship -0.009*** -0.154*** -0.021*** -0.012

(-2.69) (-2.61) (-2.78) (-1.35)

Loan purpose FE YES YES YES YES

Loan type FE YES YES YES YES

Borrower industry FE YES YES YES YES

Borrower type FE YES YES YES YES

Reporting quarter FE YES YES YES YES

ABS deal FE YES YES YES YES

N 1,968,479 2,200,333 2,200,333 2,200,333

Pseudo -R2 15.21%

Adj.-R2

5.24% 7.27% 35.69%

Transparency and securitized loan quality:

Banks with ECB repo financing pre 2013

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Transparency and securitized loan quality:

The role of information collection

(I) (II) (III) (IV)

Default Delinquent

amount

Number of days in

delinquency

Loss given

default

Transparency loan -0.027*** -0.188*** -0.054** -0.023**

(-2.75) (-2.86) (-2.45) (-2.31)

Information collection 0.414*** 1.503*** 3.428*** 0.901*

(3.37) (3.68) (2.81) (1.75)

Transparency

loan*Information

collection -0.265*** -1.605** -0.509*** -0.044

(-2.68) (-2.44) (-2.77) (-1.01)

Loan characteristics YES YES YES YES

Loan purpose FE YES YES YES YES

Loan type FE YES YES YES YES

Borrower industry FE YES YES YES YES

Borrower type FE YES YES YES YES

Reporting quarter FE YES YES YES YES

ABS deal FE YES YES YES YES

N 2,729,323 2,961,217 2,961,217 2,961,217

Pseudo-R2 15.43%

Adj.-R2

10.17% 8.23% 42.02%

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(I) (II) (III) (IV)

Default=1 Delinquent amount Number of days in

delinquency

Loss given

default

Transparency loan -0.016*** -0.155** -0.020** -0.020**

(-3.28) (-2.27) (-1.99) (-2.18)

Peers’ transparency -0.078 -0.020 -0.027 0.007

(-1.45) (-0.43) (-0.57) (0.19)

Transparency loan*

Peers’ transparency -0.009** -0.021*** -0.010** -0.005

(-2.10) (-2.75) (-2.74) (-0.72)

Loan characteristics YES YES YES YES

Loan purpose FE YES YES YES YES

Loan type FE YES YES YES YES

Borrower industry FE YES YES YES YES

Borrower type FE YES YES YES YES

Reporting quarter FE YES YES YES YES

ABS deal FE YES YES YES YES

N 2,729,363 2,961,217 2,961,217 2,961,217

Pseudo-R2 13.83%

Adj.-R2

5.89% 7.47% 41.40%

Transparency and securitized loan quality:

Market discipline

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Supplementary analyses

Do banks strategically select which ABSs to pledge to the

ECB as collateral for repo financing?

- A bank may opt to collateralize and report better performing

ABSs (i.e., ABSs secured by better quality SME loans),

while retaining low quality ABSs on its balance sheet.

Do banks sell worse quality ABSs to investors?

Can our findings be attributed to bank misreporting (banks

reporting stronger than actual loan performance)?

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(I) (II)

Participating banks Matched sample

1-yr CDS

spread

5-yr CDS

spread

1-yr CDS

spread

5-yr CDS

spread

Post-transparency -0.005** -0.006** 0.003 0.004

(-2.32) (-1.78) (0.40) (0.76)

Reporting Bank*Post-transparency -0.005 -0.010**

(-1.32) (-2.33)

Controls YES YES YES YES

Quarter FE YES YES YES YES

Bank FE YES YES YES YES

N 152 152 311 311

Adj.-R2 81.23% 88.52% 81.70% 86.87%

Transparency and CDS spreads

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(I) (II)

Participating banks Matched sample

Loan loss

provisions

Loan

impairments

Loan loss

provisions

Loan

impairments

Post-transparency -0.024** -0.017 0.001 0.010

(-0.60) (-1.10) (0.01) (0.40)

Reporting Bank*Post-transparency -0.060** -0.044**

(-2.01) (-1.72)

Controls YES YES YES YES

Quarter FE YES YES YES YES

Bank FE YES YES YES YES

N 280 280 560 560

Adj.-R2 53.60% 73.60% 66.40% 60.65%

Transparency and Bank’s financial performance

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Transparency and prices of un-retained ABSs

(I) (II)

ABS credit rating

at origination ABS price

Post-transparency -1.009*** 0.017**

(-1.68) (2.34)

Controls YES YES

Bank FE YES NO

ABS quarter of origination FE YES YES

Trade quarter FE NO YES

ABS deal FE NO YES

N 155 735

Adj.-R2 72.44% 69.31%

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Transparency and securitized loan quality

Are the results driven by EU-wide or national regulatory

changes in accounting for securitization risk and reporting

securitized transactions?

- CRD IV: more stringent requirements for banks to directly or indirectly

retain higher share of their securitized deals as well as for calculating

risk provisions in their securitized positions for capital adequacy

compliance purposes (effective date: Jan 1, 2014).

- Regulation 1060/2009/EC: credit rating agencies are required to

disclose more details of their standardized credit rating methodology

and processes (effective date: Sep 2009).

- Reg ECB/2008/30: banks engaging in securitization activities are

required to report to ECB various characteristics on their SPEs’ assets

and liabilities (effective date: 2010Q3) Spain adopted more

transparent reporting.

- Dutch securitization forum adopting standardized documentation for

securitized debt transactions (effective date: Jan 2013).

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(I) (II) (III) (IV)

Default Delinquent

amount

Number of days in

delinquency Loss given default

Transparency loan -0.011*** -0.093 -0.029* -0.013***

(-3.48) (-1.40) (-1.82) (-3.01)

Loan

characteristics YES YES YES YES

Loan purpose FE YES YES YES YES

Loan type FE YES YES YES YES

Borrower industry

FE YES YES YES YES

Borrower type FE YES YES YES YES

Reporting quarter

FE YES YES YES YES

ABS deal FE YES YES YES YES

N 1,049,883 1,068,797 1,068,797 1,068,797

Pseudo-R2 23.71%

Adj.-R2 5.45% 7.20% 35.29%

Transparency, loan performance and the effect of regulatory

changes

Restrict sample to loans originated over the 2011Q1–2013Q3 period:

most major regulatory changes had taken place prior to the beginning

of this period and CRD IV went into effect after it.

Exclude loans by Spanish (most transparent national reporting

environment) and Dutch banks (concurrent regulatory change).

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Transparency and securitized loan quality

Are the results driven by supervisory pressures and

international authorities’ scrutiny (e.g., EC, ECB, IMF)?

- Spain and Portugal have entered Economic and Financial

Assistance Programmes in 2011 and 2012.

- Italy also received rescue funds from the European Union (i.e., the

European Financial Stability Facility) in 2011.

- EC, IMF and the ECB have been launching regular review

missions to these countries to analyze economic, fiscal and

financial developments.

- Banks’ financial stability and long-term sustainability became

tightly linked to the rescue funds.

- The improvement in loan quality may be attributed to banks’

tightening their lending standards under greater uncertainty over

their countries’ long-term financial stability (e.g., Becker and

Ivashina [2014]).

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(I) (II) (III) (IV)

Default=1 Delinquent amount Number of days

in delinquency Loss given default

Transparency loan -0.012*** -0.096** -0.035*** -0.019*

(-3.43) (-1.99) (-3.18) (-1.79)

Financial stability 0.003 0.042 0.011 0.002

(1.19) (1.38) (1.03) (0.48)

Transparency loan*

Financial stability -0.013** -0.011 -0.018** 0.005

(-2.24) (-1.52) (-1.98) (1.16)

Interest rate 0.009*** 0.162*** 0.037*** 0.006**

(7.26) (9.85) (6.11) (2.07)

Secured 0.011*** 0.087 0.031* -0.057

(2.64) (1.53) (1.72) (-1.36)

Years to maturity -0.001 -0.450*** -0.008 -0.042***

(-0.36) (-3.77) (-0.69) (-5.83)

Securitized loan amount 0.007 0.134 0.046** 0.049***

(1.42) (0.40) (2.02) (3.02)

Lending relationship -0.007*** -0.043 -0.010 -0.013

(-2.81) (-1.28) (-1.48) (-1.45)

Loan purpose FE YES YES YES YES

Loan type FE YES YES YES YES

Borrower industry FE YES YES YES YES

Borrower type FE YES YES YES YES

Reporting quarter FE YES YES YES YES

ABS deal FE YES YES YES YES

N 1,282,203 1,482,599 1,482,599 1,482,599

Pseudo -R2 18.13%

Adj.-R2 9.58% 7.23% 41.63%

Transparency, loan quality and the and the effect of

international monitoring pressure

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Conclusions

Loans originated under the transparency regime are of better

quality in terms of their default probability, loss given borrower’s

default and late principal and interest payments.

Banks with better information collection as well as banks

operating in more transparent credit markets experienced greater

improvement in loan quality under the transparency regime.

The agency costs and risk taking inherent in

securitization can be alleviated by increasing

transparency.

Our results do not imply social welfare benefits, as the economic

benefits of transparency may not outweigh its costs (e.g., Dang et

al. 2014).

Page 24: Enhancing Loan Quality through Transparency: Evidence from ......Motivation Loan securitization is an important credit market innovation that allows banks to diversify credit risk

Contribution (1)

We add to the literature that explores the agency costs in loan

securitization (e.g., Keys et al. 2010, Keys et al. [2012], Benmelech

and Dlugosz [2009], Benmelech et al. [2012], Garmaise [2015]).

- By showing that higher transparency can alleviate inefficiencies

inherent in structured finance.

We contribute to the literature on the role of transparent reporting

in the banking industry (e.g., Beatty and Liao [2014], Granja

[2014], Bushman [2014], Acharya and Ryan [2015], Costello et al.

[2015]) and on the role of banks’ financial reporting quality in

alleviating risk-taking (e.g., Nier and Baumann [2006], Bushman

and Williams [2015])

- By documenting a direct link between reporting transparency via

loan-level disclosures and the quality of banks’ lending decisions.

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Contribution (2)

We contribute to studies on the role of banks’ transparent

reporting in credit crises (e.g., Laux and Leuz [2010], Barth and

Landsman [2010], Laux [2012], Bischof and Daske [2013], Bischof

et al. [2015]).

- By stressing the role of transparency in alleviating risk-taking

behavior.

We extend we extend the emerging literature on the role of

transparency in improving operational decisions and

organizational performance (Christensen, Floyd and Maffett

[2014], Buell, Kim and Tsay [2015], Mohan, Buell and John [2015]).

- By delineating two important channels through which transparency

leads to better credit practices.

- We show that both the information collection and the market discipline

channels are instrumental in insuring higher loan quality.

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